3 Things Govt and RBI Can Do to Keep the Feel-good Factor Going
next? To keep things straightforward, we list three things the government and RBI may do to keep the feel-good factor going.
What the RBI needs to do. To begin with, the April monetary policy indeed promises to be a game changer as it tries to move the system liquidity to neutral. It is indeed a comedy of errors that some commentators are even making an outrageous comparison of this policy to QE.
Coming back to the central theme, one logical corollary of the policy announcement is that the apex bank will possibly need to do a lot of open marketoperationsthisfiscaltoinfuse durable liquidity. Herein lies the problem.Ithasbeenobservedthatthe residual excess SLR (after taking into account the adjusted HQLA) availa- ble for repo operations has been declining and almost touched zero towards the end of March. This is not strange, as the RBI inventory of government papers are getting depleted and it is unable to increase the stock of government paper for fiscal ramifications. Also, unlike other countries, the Indian central bank is not empowered to float its own securities. Thingshavebeenfurthercompounded by the RBI’s withdrawal from primary market auctions of government paper from April 2006 as per FRBM stipulations. Additionally, investors in masala bonds wishing to hedge their foreign currency exposures with Indian banks may also need G-secs as collateral.
We, therefore, suggest that the RBI quickly move to non-collateralised marginal standing deposit facility suggested in the Patel committee. However, since this entails a revision to the RBI Act, in the interregnum, RBI may allow corporate bonds to be used as eligible collaterals alongside G-secs. Such a move could act as a double whammy as it would also enable a deepening of markets through increased trading even in illiquid papers.
What government needs to do The second point also has to do with liquidity. Since December 2015, our financial markets witnessed unprecedented liquidity tightening. The reasons were manifold: LCR, credit growth, increase in currency with public and, of course, the unspent cash balances of the government. System deficit touched Rs3 lakh crore in March.
We, therefore, suggest the government cash balances may be placed with a bank so that the money stays within the financial system. The government may choose to spend the money accordingly without disturbing the systemic liquidity. It will also provide a clear picture of the money available within the system not getting distorted by government borrowing. Meanwhile, the cash balances of the government become a part of durable liquidity and, thereby, even negate some part of OMO purchases. This step also increases government’s revenue as the funds can bekeptinaninterestbearingaccount with banks. We understand that this also requires amending the RBI Act.
What RBI & government need to do Finally, RBI had opened a special swap window for FCNR (B) deposits in September 2013 to attract foreign exchange. This scheme was a roaring success as around $34 billion were raised by banks with maturities ranging between three and five years. These deposits and swaps will start maturing from September, which may possibly lead to dollar outflows. The good thing is that, as per available data, RBI has hedged its swap positions in the relevant maturity bucket. It also implies that overall banking system’s swaps are also hedged in this bucket.
We propose the government, in con- junction with RBI, launch a special option product akin to the FCNR (B) scheme. It may be noted the implicit RBI subsidy at 3.5% for the FCNR scheme had ensured that the product was a hit with the market. Along similar lines, if we offer any option productwhereinanydepreciationbeyond say 4% is guaranteed by banks with premium payable within 2%, we are convinced that given India’s infrastructural needs over the next couple of years, this could be a god-sent opportunity for the country (China followed a similar path for several years). Details can be worked out separately. Remember, $34 billion came in at a time when India was bucketed in the fragile five, but now India commands at least an equivalent amount if not more based purely on its strength.
For better liquidity, govt cash balances may be placed with a bank so that money stays within the financial system